Alan Kohler & Eureka Report Podcast | Marcus Bogdan, CIO Blackmore Capital
Updated: May 11, 2021
Blackmore Capital's Chief Investment Officer Marcus Bogdan talks about being focused on earnings quality, earnings resilience and balance sheet strength, particularly when times are tough.
This week’s fund manager interview is with Marcus Bogdan who is Chief Investment Officer of Blackmore Capital, which has a couple of funds: an equities portfolio and an income portfolio and they’ve been going for seven years or so.
Marcus, welcome to the Eureka Report. Tell us a bit about the funds. You’ve got two funds, blended Australian equities, and Australian equities income portfolio. How big are they? How much money is in them?
We’ve got about $300 million across both of the strategies. I established the two strategies seven years ago and then we created Blackmore Capital three years ago. A relatively new company, but the strategies have got significant history now and thankfully we’ve gone through one economic crisis as well, so we got through that as well.
What was your own background before you started these things?
Well, my background has always been in equities. I started in 1991, really at the last Australian recession. I joined as a young analyst at McIntosh, which became Merrill Lynch and worked as an analyst for that decade. That was a great time to start because we were coming out of the worst banking crisis that we’d seen in Australian history at that point in time. We had the State Bank of Victoria, State Bank of South Australia, Pyramid – a whole range of things – and Westpac also was under incredible economic duress then. As a young analyst, looking at what leverage and interest rates could do to balance sheets at that point of time really seeded me well for a long-term career in equity analysis.
What sort of investment philosophy has that led to? What approach do you bring to investing?
We’re a long-only investor, so we really want to align ourselves with the companies that we’re investing in. We’re long-term. It’s a low turnover portfolio. There’s certain characteristics which are particularly important to us and those characteristics have been demonstrated throughout that 30 years through a banking crisis, the tech boom and crash, global financial crisis and more recently, the pandemic. We pay a lot of attention to earnings quality, earnings resilience, and what I alluded to previously is balance sheet strength.
We really look at the philosophy and the framework around probably the biggest component in the portfolio would be quality at a reasonable price. Trying to find those resilient businesses at a reasonable price. That would be 50-60 per cent of the composition of the fund. Then we sort of flex and contract between growth and value as the other two drivers in the portfolio.
What do you charge? I think your management fee is 0.6 per cent, but do you have a performance fee?
No. It’s a flat fee of 0.6 per cent. The platforms have a platform fee on top of that, so the all-in fee is well under 1 per cent.
And a minimum investment of $25,000.
Yes, because generally the portfolios are invested across around 24 to 26 companies.
Just looking at the equities portfolio, the top five - you only tell us what the top five are, Westpac, BHP, CSL, CBA and Woolworth’s.
These are all top 20 stocks really, so you’re not exactly a growth investor investing in Afterpay, are you?
We do have that basis there in those quality companies but we didn’t have the banks in the portfolio from 2015 to 2018 and so we actually put the banks back into the portfolio on the day of the Royal Commission, when Justice Hayne brought down the Royal Commission. We are agnostic to the market but we are really focused on quality, so you will see those headline banner names in the portfolio and material positions in there. But we do have a range of midcaps because our universe is the ASX 200 as well. We can be quite overweight those sorts of companies in the portfolio and they’ve tended to provide our active outperformance over time as well.
What’s the difference between the income portfolio? Because I look at the top five holdings in your income portfolio and it’s Westpac, CBA, BHP, Macquarie and Woolworth’s.
They don’t seem terribly different, to be honest.
No. The two portfolios are definitely based on the same analytical framework and they share a lot of characteristics. The difference is really the income portfolio has to have companies that pay dividends. The blended portfolio can have companies that don’t pay dividends such as Xero, or companies where the dividends are very, very low, such as a News Corporation. There’s about five different names in the income portfolio compared to the blended.
With the income portfolio you tell us what the performance is, which is slightly lower than the equities portfolio, but you don’t tell us what the income is. What’s the income?
The income at the moment is around 3.8 per cent, that’s the 12-month forward dividend yield there and then on top of that there’ll be franking on that as well. Just the way that we look at income, we want to have companies that prima facie pay high dividend yields, but possibly will have low earnings growth, so that will be a component of the income fund. The second characteristic we like to look at is those sort of good industrial or consumer staple companies which may be paying dividends between 3 or 4 per cent but are generating slightly higher earnings per share growth.
And then we have a smaller component where the dividend will be lower but then the growth rate of those companies will be higher and then hopefully that will translate into higher dividends. The headline dividend yield of sort of 3.8 per cent, it’s sort of averaged around 4.3 per cent over the seven years, but we do like to ensure that those dividends are sustainable and also grow over time as well.
I’m just interested, you don’t seem to be marketing it as an income investment for investors to get an income. Do you know what I mean? You don’t seem to be marketing the income from it. Is that right? How often do you pay a distribution, for example?
The nature of the way that the investors through a separately managed account, is that they’re the beneficiary owners of the companies and so they hold the stocks in their own entities and so…
These are SMAs? I didn’t pick that up.
Yeah, and so they receive the dividends primarily twice a year, or some companies pay quarterly, but most would pay half yearly. And to your point, the investment objective really of both those portfolios is to grow capital and income over a rolling five year period, but to do that with lower volatility and lower investment drawdown. What we really pay a lot of attention to and is really a core objective of the portfolio, is because we’re focussed more on the quality side of things, earnings tend to be lower volatility and it tends to give us better downside protection in periods of economic duress and that’s something that we’ve measured very, very carefully over the seven years.
Do you have a minimum and maximum cash level in the portfolios?
Yes. We can hold up to around 20 per cent cash in the portfolio. The average over the seven years has been around about 6 or 7 per cent. At the moment, in the blended we’ve got about 5 per cent cash and about 3 per cent in the income. We’re primarily almost fully invested.
Does that tell us that you’re feeling bullish at the moment?
Well, we’re certainly bullish on the economic recovery that we’re seeing. I think from a macro perspective, from a company perspective it has been far better than we and market participants have anticipated. But I think it is now very much built into the price. The indexes have recovered almost 99 per cent to the pre-pandemic level and then we’ve seen a commensurate uplift in earnings there as well. I think by the end of this financial year, 2021, we expect earnings to have caught up around 95 per cent. The valuations are certainly matched by the fundamentals but I think we’re seeing that exponential rise now and I think now it will be far more workmanlike going forward.
What do you mean by ‘workmanlike’? You mean low returns?
Well, I think certainly lower returns going forward and back more to sort of long-term averages and as an active investor now, our attention is looking at things that have actually lagged this rally. The rally that we’ve seen, you’ve seen a very strong uplift in cyclical companies and now our focus is looking at those higher-quality companies that have just not kept up with the market. I think over time their earnings resilience and their dividends will be attractive investments because I think we’re being able to get them below fair value.
How do you find those stocks? What are your screens?
We have an analytical framework that we look at every company that we have in the portfolio. It starts with the earnings and we’re very much interested in the history of earnings and the history of returns because I think that gives us a good grounding of what to expect in the future. In essence we’re really trying to work out where each individual company is in its own earnings cycle. The second framework that we look at is the industry characteristics, the size of the industry, the returns of the industry and also the regulatory overlay that sits across that. I’ve mentioned before we are attracted to companies that we believe have sustainable balance sheets. Companies that can invest counter-cyclically and I think both earnings and balance sheet have proven the test of time, certainly in my career.
We do spend a lot of time speaking to the companies directly, and to competitors, and to industry participants, and so from a management perspective understanding what they’re actually saying and what they’re actually executing on and understanding the catalysts to either create future shareholder value. ESG has certainly become far more prominent in the last 18 months and so we screen companies through the particular industries and the material aspects that occur from an industry perspective. And then we have to value them and we want to value companies through a range of different prisms. There’s not one golden number that we look at and so we use relative methods of valuing companies. We use classical DCFs and we use a sum of the parts valuation as well and then we’ve got to put all of that into a portfolio and we want that portfolio to be able to exhibit resilience and also better performance, particularly when times become more difficult.
You obviously like Westpac. That’s the largest holding in, I think, both of your portfolios. Why do you like it? I note that they’ve outperformed the other banks this calendar year so far, so are you starting to think of lightening off your holding now that they’ve done that?
Westpac we put into the portfolio for the first time in October and November. We’ve got, I think, in terms of earnings quality, the best earnings quality in terms of CBA and we’ve had the one that’s laggard the most in Westpac. We’re more focused on certainly the mortgage market and the recovery there and that’s been underpinned by what we’re seeing in terms of the housing recovery. We do think that expenses now have started to moderate and what we’re seeing today is that they’ve got quite an aggressive cost-out program for the bank. We see the banks more broadly as good recovery plays in this economic cycle and we certainly want to be overweight the housing market as well.
In terms of where we are at, we don’t feel like the banks are yet over-earning, ROEs are still around 9 or 10 per cent. I think the capital positions are particularly strong. In a low interest rate environment with dividend yields now coming back to 4.6-5 per cent and then franking on top of that, I think you’ve had probably the strongest recovery now, but I still think from both a capital and a dividend perspective, those returns from a relative perspective will still be attractive.
You also like BHP. You’ve got close to your maximum holding in BHP. Are you worried about the iron ore price coming down now?
The iron ore price has certainly been a lot stronger and for longer and we’re starting to see the first evidence of China slowing down and certainly when we look at BHP into the future we’re not forecasting iron ore prices at $190. We’re looking at long-term averages of $70-80. But they’re still generating an incredible amount of free cashflow. They’ve been disciplined on capital expenditure and I think there are going to be issues ongoing around supply. The balance sheet is very strong. But BHP is one of the first recoveries, as China has recovered. And again, we’ve seen the biggest uplift that we’re seeing in the share price in terms of that recovery now, but I do think that both earnings and dividends should be favourable for investors certainly over the foreseeable future.
In your recent quarterly, you said that the only thing that matters to asset prices is fiscal and monetary policy largesse. Does that worry you a bit, that really for investors, it’s all about what governments and central banks are doing?
Well, we’re in a great economic experiment here at the moment and if you were sort of thinking about the risks that we’re thinking about is certainly about his new environment around the extent of fiscal spending. Originally, we thought one of the risks was that they would be turning the taps off too early. We’re certainly not seeing that, particularly in the United States and I don’t think we’ll see that in the budget that we’ve got coming here, certainly prior to the election. Ultimately there is a potential risk there that with both easing monetary policy, expansive fiscal policy, that you do get misallocation of capital, that you get a level of hubris built into expectations. And so they’re the sorts of things that we are watching very carefully, both at a company and at a portfolio level. But at the moment the economic returns that we’re seeing, we’re still seeing pretty modest inflation here as well. It continues to support pretty good earnings growth for Australian companies.
We’ll have to leave it there, thanks very much, it’s been great talking to you.
Thanks very much, Alan.
That was Marcus Bogdan who is the Chief Investment Officer of Blackmore Capital.